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December 2009 Edition ----

We have been slow to pick up on the fact that Joan Withers has been appointed chairperson of the government owned Mighty River Power. We deplore this apparent attempt to sanitise Ms Withers.

Ms Withers joined the board of Feltex Carpets Ltd in April 2004. We believe she was asked to do so by politicians and told that she would be looked after regardless of the consequences of joining Feltex. A few days later Feltex released a prospectus to raise a shareholding to buy the company from the existing owners in its entirety and to improve the capital position of the company a little. The company was facing falling tariffs in both Australia and New Zealand where it marketed its carpets. Originally all its carpet making facilities were in New Zealand. It profited under CER which enabled it to compete effectively in Australia. Then with the tariffs falling it bought the Melbourne plants of Shaw Industries in the year 2000. Shaws, the world’s largest carpet maker had decided to cease manufacturing in Australia. Feltex failed to make a profit in its June years 2001 and 2002. The prospectus falsely claimed that a 1%p.a. growth in the market size which Feltex was assuming in projecting its 2005 result was ”below the average growth rate of the past 10 years”. Feltex’s calculation was not an averaging one in that it took only the two years, 1993 and 2003, into account. The market size in those years was not typical of other years at the respective ends of the 10 year period and 1993 is not included in the last 10 known years. Similarly Feltex assumed a 1% growth in which was wildly unrealistic given that it had been losing market share at the rate of 5% of its over the last known three years.

Despite all this information being available from a careful reading of the prospectus Ms Withers consented to her name and photo going in it as the only woman director and so lured about $200m out of “Mum and Dad” small time New Zealand investors.

Then in early 2005 when Feltex announced a major profit downturn from that projected in the prospectus did she stay on to see that shareholders got the very best deal in the “unfortunate” circumstances? No show, it was “out of here” for her. We believe her political friends who talked her into the job got sports hero David Kirk to offer her a top executive job. He ends up with a seat on Forsyth Barr, we think for his troubles. She was able to keep one directorate with this new job. Did she choose Feltex because the shareholders there were in need and had a right to expect that she would be with them for more than a year? No show, she wanted to stay with the country’s major airport which was doing quite nicely thank you. Did she leave Feltex in good hands? Not a bit. The remaining directors and a replacement for her appeared to bungle around and lost every dollar of shareholder’s funds as well as quite a few million of creditor’s funds or so the creditors claim. Five of those directors face criminal prosecution by the companies office.

Ms Withers had the cheek to get her solicitor to write to us when we suggested or stated that the Feltex IPO was a swindle. We say you have to understand the implications of a prospectus word by word before you allow your name and photo to go into it as a director. She knows full well that that up down and up graph on page 37 did not fairly represent 1.7% growth. More importantly changing from a regular 5% loss of market share to a 1% gain is a very tall order and needed to be fully spelt out and acknowledged as such. She knew the fact that the vendors wished to exit entirely made the offer highly suspicious. She knew carpet manufacture was labour intensive and tariffs were declining.

Ms Wither’s solicitor said of one of our statements “it meant and would have been understood to mean my client acted fraudulently, dishonestly and/or stole money from investors while a Feltex director”. We thank him for his services. We would have difficulty expressing it so distinctly ourselves. She failed to study the suspicious prospectus before putting her name to it, or if she studied it she ignored her findings, and would have known that innocent people would lose money as a consequence. Probably she did not foresee a total collapse. She just thought that profits would languish and it would be taken over by someone else.

She and her fellow Feltex directors face no criticism from the Securities Commission because of the actions of one Kevin Simpkins who failed to report on the validity of the 1% market growth and the 1% increase in market share assumptions. We say like Ms Withers, Mr Simpkin is also flying high for his Feltex efforts, being now chairman of the board that is apparently destined to become the official auditing review board. Mr Simpkins deserves similar condemnation.

We also have little more respect for the new deputy chairman of Mighty River Power, one Trevor Janes. Mr Janes as we understand it was on the board of the Accident Compensation Corporation and chairman of its “Investment Committee” until 1 November 2002 when he was displaced by fellow accountant and sharebroker Eion Edgar. We put “Investment Committee” in quotes because it does not seem to take responsibility for the actual investments which the Corporation makes. It sets parameters and benchmarks and reviews performance apparently. We think the name should greater reflect its functions. Anyway during this tenure of Mr Janes on the board the Corporation bought half a million dollars of Nation Mail shares a few days before that company announced that it had not been successful in the mail business and was getting out of it. The resulting loss was about half a million. The shares were bought from Cliff Cook whose close business associate Peter Fitzsimmonds was on the board of National Mail. It never occurred to ACC that the vendor might know something, apparently, according to them, if you want to believe it. As well the Corporation has sharebrokers to advise it. The Corporation apparently uses a large number of brokers so that in any given situation they can always find a broker which is independent of brokers engaged by the other party or parties. So in this case Mr Cook used CS First Boston so ACC chose a firm Credit Suisse FB. Perhaps we have these names the wrong way around. We say this is not good enough. Credit Suisse First Boston exited retail sharebroking in New Zealand soon after that as did these related names. It could be that authorities threatened action if they did not.

But Mr Janes was off the Investment Committee for one year only and in November 2003 was back on as a Specialist Member in good time for the Corporation’s “subscription” (we prefer the word “donation”) to Feltex Carpets Ltd in May 2004. The words “Cedit Suisse” are contained in the name of the promoter and vendor in relation to this issue. We will not go over the defects in the prospectus and its background that would have alerted Mr Janes to the fact that this offer was to be avoided. They are the same defects that would have alerted his close associate the chairperson of Mighty River and most every other investor and advisor and brought them all to the same conclusion. But he presumably did not contact the ACC investors and say “hey be sure to lay off that one”. We think he did what political friends on both sides of the political spectrum wanted him to and either said nothing or encouraged the ACC investors to go along with it. Because Eion Edgar obviously had a vested interest in the Feltex float we say it was Mr Janes’s job to come to the fore and evaluate it independently.

So for very similar terrible reasons involving Feltex, Withers and Janes now sit alongside one-another steering the Mighty River. Don’t get in the way of it.

Its funny how both surnames end in an s. We almost called the former Joan Rivers at one stage. The two are not to be confused.

Let us leave off Feltex for a moment. We wish to complain about aspects of the audit of the 2009 annual accounts of the Accident Compensation Corporation.

The certificate uses the pronoun "we" to refer to the communicator(s) except on one occasion it uses "me" to refer to B R Penrose. The document is signed on behalf of the Auditor General and I say the whole message should use "I" and if necessary "me" and "my" and purport to be coming from the Auditor General. I do not know whether the new appointee of Auditor General was in office at this time. If she was it should say "my predecessor appointed B R Penrose to carry out the audit". Audit certificates need to define exactly who is responsible for the work. Reference to "we" is too all embracing and readers might assume that others are included when they have no responsibility.

We also object to the report being on Ernst and Young letterhead when it would appear that this firm is not necessarily responsible for the proper performance of the audit. The same applies to the words Ernst and Young above the signiture. The contract appears to be with B R Penrose only. If Ernst and Young are also responsible then reference to using Ernst and Young staff and resources would be redundant. Using that letterhead confuses the issue when the firm has no contract. Many browsers of the annual report would assume that Ernst and Young had done the audit from the letter head and would have read no further. Not that reading further would necessarily have clarified the situation. The Auditor General's letterhead would have been satisfactory as would no letterhead at all.

It needs to be clearly explained that B R Penrose is a partner of Ernst and Young if that is the case or other brief details of his/her background need to be explained.

We object to the report document not being dated. We appreciate that there is a paragraph saying the audit was completed on 24 September 2009 and that is the date at which "their" opinion is based but for many possible reasons that may not have been the date on which the report was signed. Taking a few days out to reflect upon one’s judgment before signing is perhaps good practice. Auditors are not entitled to backdate their opinion to some convenient point of time when genuinely and fairly they were unaware of some happening or relationship that brings the accuracy or integrity of the accounts, or their obligation to report post balance date events, into question. Such dates can be critical as for instance when the auditors were told, before the 1990 annual accounts had been released, of the need for the Bank of New Zealand to be bailed out for a second time. It is traditional practice to date all documents and that should continue.

5 Under the heading "independence" in the audit report the auditors, whoever they are, say that other than the audit and stated other assignments they have no relationship with or interest in the ACC. We claim that an historic close business relationship of the signer of the audit document and the ACC chairman at the end of the reporting period is a very relevant relationship that should have been declared there. The chairman John Judge apparently retired from the position of Managing Partner at Ernst and Young on 30 June 2007. We are not sure when B R Penrose joined the firm but it is some time earlier than that. B R Penrose was contracted to undertake the 2007 ACC audit using Ernst and Young staff similar to the 2009 situation.

We suggest that the chairperson is the single most influential person in the ACC organisation. As managing partner we understand one of Mr Judge's functions was to investigate and action complaints about partners of the firm. We expect he had compiled a little dossier on most partners. It would perhaps be best not to stand up to such a person or perhaps embarrassing details could be leaked to unwelcome places. Also Mr Judge might have been able to form valid opinions of B R Penrose's weaknesses or peculiarities as an auditor and have got some changes made to the accounts which he knew would not be challenged. More likely however is the possibility that the two are the best of mates and will go out of the way to help one-another.

It will probably be claimed that in a small country such conflicts are unavoidable. That might be so but declaring the worst of them is an easy method of helping reduce the harm from such conflict.

It is hard to visualise a relationship with a corporate body such as the ACC. We claim that it will be inferred that there are no relevant relationships with influential ACC personnel including historic ones which we believe is untrue.

Back to Feltex. Here are some numbered paragraphs or whatever that we started the month off with.

1 We attended parts of an Court of Appeal hearing on 24 to 26 November. The appellants were the defendants to “representative” actions by certain subscribers to the May 2004 Feltex Carpets Ltd IPO, headed by Eric Houghton.

2 Very few observers were present at this hearing. No reporters from the mainstream media appeared to be there. Some articles appeared in this media at the start of the hearing and these appeared to be based upon written submissions made.

3 The respondents ie the shareholders have changed their legal representative. They had one barrister, John Eichelbaum representing them at the hearing as opposed to a total of 5 representing the various appellant parties. Mr Eichelbaum confessed to be less that optimally prepared.

4 An allegation was made about the person referred to as the funder of the shareholder’s action concerning inaccuracies in communications made by the funder to shareholders following the release of a Securities Commission report into the Feltex IPO. The Judges appeared to take a dim view of the allegations, which seemed to go undefended. They seemed mindful however that no other funder may be available and the shareholders might have just cause for the action.

5 An amended Statement of Claim was submitted by the respondent. Judges expressed concern that this was barely adequate in detail.

6 Judges appeared to be sceptical about claims that subscribers to the Feltex issue should not be able to recover funds if they had not personally read the prospectus.

7 The amended Statement of Claim appears to be mainly based upon criticisms of the IPO made by Professor Sue Newberry and suggests that profits claimed by (then) Feltex Carpets Ltd , now EXFTX Ltd, for its 2003 and 2004 year and first half of its 2004 year were not genuine. Evidence from at least one retailer was being relied upon in this regard. It was alleged that these profits were “obtained” by putting sales that would normally be made in July into the earlier June year. This might have been done by dispatching a typical July order in June and telling the retail client that they need not pay until August. Another alleged tactic used in this regard was to cancel a rebate which was part of the normal transaction process, the aim being to increase the value of sales attributed to a certain period.

8 The decision of the Court was reserved.

9 That completes our comments on the hearing.

10 We call upon subscribers to the Feltex IPO to adopt a more straight forward approach to getting their money back, hopefully with interest, by demonstrating that the assumption of 1% p.a. growth in market size was improperly justified in the prospectus, and the assumption of 1% p.a. growth in revenue due to increased market share was completely unrealistic and not directly shown to be so in the prospectus.

11 This approach does not depend upon a successful discovery process.

12 We say again that the trend in the Australian carpet market size for the 10 years 1994 to 2003 as measured by least squares regression analysis, as provided by the forecast function on Microsoft Excel, predicts a market size for 2005 which is 3% less than the actual figure for 2003. The sizes of all 10 years influence this calculation. The Feltex prospectus at page 37 claims growth of 1.7% p.a. compounding but is based only upon the sizes of the 1993 and 2003 years. As can be seen by the graph on page 37 the sizes of these two years are fortuitus for forecasting a large amount of growth from such a flawed process. Adding in the New Zealand market sizes changes the measurements by either method very little. On page 91 under the heading “industry conditions” Feltex say they assume that the market size will grow over the projected period by 1% which they say “is below the average growth rate of the past 10 years”. We say this statement is wrong and highly misleading because an acceptable method of averaging the growth has not been used. A method which takes the size of all of the last 10 years for which data was available is needed. The difference between a 1% increase and a 3% fall is some $12m of revenue which probably equates to about $6m of profit.

13 With respect to market share we say that Feltex has failed to spell out its recent history with respect to market share in its prospectus and if it had done so it would be apparent that the 1% increase in share over the projected period is unrealistic. There is a requirement for all assumptions used in compiling projections to be realistic. This critical assumption is not realistic. We accept that Feltex acknowledges that it was assuming some improvement in market share by 2005 by virtue of its comment “that Feltex will successfully implement the strategies under the heading Business Description resulting in” Feltexs share increasing by approximately 1% over the projected period. Well business description is the title of a section of the prospectus starting at page 14. At page 51 we come to the heading Feltex strategies. We say these strategies are common sense and will have been applied by the company from day one. There is nothing new there which might be seen to turn around an appalling trend in market share. We must emphasis the extent of the turnaround necessary which is contained in the prospectus but not in a way that the average potential investor could pick up upon. This was a drop of 5% p.a. in the intervals between the years 2001 and 2003 as we have previously calculated. There is no reason to believe that this decline would diminish.

15 From these workings it can be deduced that Feltex’s projected revenue for 2005 has been overstated by $20m with respect to market size and another $40m with respect to market share a total of $60m a large portion of which, probably more than half, would be profit.. Such a fall fully explains Feltex going into receivership and liquidation when it did.

16 The Feltex case is one of accounting failure, both on the part of those who compiled the prospectus but also on those who have reviewed it since. Corrupt accounting cannot be allowed to fill the needs of wayward politicians. Accountants have a duty to come forward in mass and condemn what has happened here.

17 We say the claims that Feltex did not genuinely make a profit at any time since at bought the Australian plant of Shaw industries are probably correct but seeking to prove such is an unnecessary complication in the process of recovering the IPO subscription funds.

18 We say that if the Feltex IPO is “rotten to the core” which is the expression used to the Court of Appeal then it is only logical that some false advocate for the subscribers would be provided by those who collected the money to use up the protesting energy and resoiurses.. Mr Eichelbaum who is now representing the subscribers action represented defendants in the winebox enquiry. We are not convinced that the case is going in the right direction.

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